Credit Score 101
A good credit score can help increase the success of many life events, like taking out a mortgage, financing a car and securing a new job. Having a high credit score will also qualify you for better interest rates and saves you more money in the long run!
Credit scores clearly have a big impact on how we live our lives, but what is a credit score exactly, and how is it calculated? If you have a low credit score, is it possible to improve it? These questions and more are answered below in our basic overview of credit scores.
What is a credit score?
A credit score is a number used to describe your financial credibility to others. A credit score is meant to advise lenders and let them better understand if you’re likely to repay funds in full and on time. The numbers will vary depending on which credit bureau your score was pulled from.
Why do I have different scores?
One person with one credit history should have one credit score, right? Unfortunately, no. There are many credit bureaus, but three major agencies in the United States: Experian, Equifax and Transunion. Each bureau uses their own data sets to define your credit score. If your credit history is the same, why would a credit score vary? There are two reasons:
- Creditors can choose whether to report data to one or more bureaus. That means it’s very possible that not every bureau has the same information, causing them to score you differently.
- Credit bureaus may use various scoring models that weigh certain factors and actions differently. This helps lenders make more accurate decisions about your credit.
Why is having a good credit score important?
When you apply for credit, the lender needs to understand your credit history, among other things, to determine if you are able to repay the amount you’re requesting. Your credit score is used for things like credit card applications, apartment leases, car financing, cell phone contracts, personal loans and more. If you do not have a good credit score, you might find it challenging to get the approval needed for the above necessities.
What goes into a credit score?
Your credit score is based off of a compilation of your credit history, commonly called a credit report. There are many factors that are included on this report, including the following:
- Late or missed payments. If you made a late payment, it may show up on your report and continue to negatively impact your score for up to seven years.1 At that point, it is removed and no longer affects your score, but you can see how important it is not to make this simple mistake.
- Current debt balance compared to your credit limit. For example, if you have $500 of credit debt and your credit limit is $10,000, your credit score will not be harmed much by the balance (5% of your credit). If you had the same balance of debt but just had a $1,000 credit limit, or used 50% of your available credit, that would likely lower your score.
- Length of your credit history. The longer your credit history, the better. A longer credit history allows a lender to see loans you’ve paid off successfully, an indication of consistency over long periods of time.
- Diverse credit history. Lenders appreciate seeing a variety of credit options to show that no matter the circumstance, you’re a responsible lendee. If someone only has several lines of credit or a long list of installment loans, it won’t discredit you, but it doesn’t help improve your score.
- Bankruptcies and other major financial filings. Negative financial events will get logged on your credit report and act as red flags to lenders. Know that these will have a major impact on your score, and you won’t always get the chance to explain the circumstances of these types of events.
- Credit inquires. If you are constantly applying for credit, it serves as a red flag to potential lenders. They may see the frequent inquiries as a sign that you are frequently in need and don’t get approved — thus why you have multiple recent hard credit checks on your report.
How do I improve my credit score?
If you are frequently getting denied credit access, or if you are challenged by high interest rates, it’s time you took a hard look at your credit history and reflect on areas to improve. Give creditors a reason to believe in you and your ability to repay your debts. Here are a few ways to address your low score and improve it quickly:
- Work on paying off your current debt to free up your credit limit. Generally, you should be using up less than 30 percent of your rolling credit at any time. If you maintain a balance over a long period of time without paying it down, it will eventually start to harm your credit.
- Make sure you never miss a payment. If you have an existing late payment but are otherwise on-time, call your lender to see if they are willing to forgive this instance of delinquency. Set up automatic bill pay with your bank or create calendar reminders to help you stay on track.
- Avoid making multiple credit inquiries if you can. Focus on paying down the debt you already have rather than opening new lines of credit.
- Don’t close out old accounts. As your accounts grow older, so will your credit history, which will effectively raise your score over time.
1DeNicola, L. (2020). How Long Do Late Payments Stay on Credit Reports?
The information in this article is provided for educational and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial, legal or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.